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Thursday's announcement by the U.S. administration of a "Financial Crisis Responsibility Fee" has turbo-charged an already heated debate "“ not just on the merit of an incremental tax on banks, but also on its design and the distortive manner in which it could impact on individual institutions.
While interesting, these are no longer the relevant issues. We have left the realm of what should happen and are now embarked on what is going to happen. Specifically, Thursday's announcement marks the beginning of the era of banks being targeted for selective incremental taxation in advanced economies round the world.
Seldom will you find a tax proposal that is viewed by so many as having so much going for it. Consider just four arguments.
First, it is politically popular.
At the simplest level of analysis, the tax offers an immediate signaling device for governments eager to respond to the anger in the streets about bank bonuses and the surge in unemployment. At a deeper level, it marks the end of the flawed vision that a finance-dominated economy is a natural stage in the maturation of post-industrial societies.
Second, it targets a sector whose visibly higher earnings have benefited enormously from the exceptional measures taken in 2008 to save it.
This is not just about banks' receipts of capital injections, most of which have been repaid, and of guarantees to back their market borrowings. It is also about a monetary policy stance that pins policy rates at an exceptionally low level to counter the collapse of credit. The resulting steep interest rate curves are extremely powerful in generating high earnings for deposit-taking institutions in advanced economies.
Third, it is consistent with longer-term regulatory objectives.
The fee targets large banks and, also, their balance sheet leverage. As such, it supports the authorities' desired intention to reduce systemic risk and counter the "too large to fail" syndrome.
Fourth, it generates budgetary revenues at a time when fiscal deficits have soared, domestic debt is growing at unprecedented rates, and the scope for corrective measures is limited.
In themselves, these four issues make higher selective taxation of banks a done deal. So, rather than argue about it, we should be focused on how the phenomenon will expand, in the U.S. and beyond.
It would not surprise me if, in approving the U.S. administration's proposal, Congress were to also take steps to make the tax on banks more onerous.
There is no magic to the announced rate of 0.15 percent. A higher rate could easily materialize. And the definition of the multi-year target for total receipts "“ "to recover every single dime that the American people are owed" "“ is itself subject to different interpretations.
I also suspect that other industrial countries will quickly follow the U.S. in adopting a similar tax. They too will find irresistible the four arguments cited above.
Yes, there will be efficiency losses and economic distortions associated with the selective taxation of banks. But such considerations will fall on deaf ears.
Moreover, this is not where the main risks lie. The real danger is that the selective taxation of banks may divert attention away from growing policy inconsistencies and, thus, may inadvisably substitute for urgently needed structural and regulatory measures.
Banks today find themselves in a highly contradictory position. They are being urged to lend more to help the struggling real economy while, simultaneously, being de-risked in order to lower the systemic threat they pose.
This inconsistency is indicative of a much wider challenge for industrial countries today. At a time when unemployment has soared (and will likely remain at socially problematic levels), governments' degrees of freedom are quickly being eroded by mounting concerns about fiscal deficits and the ballooning of sovereign balance sheets.
The Financial Crisis Responsibility Fee is understandable and defensible. It will continue to attract lots of attention and heated debate. Yet, in itself, it will not be a major determinant of the longer-term outlook for the advanced economies. In fact, it does little to address the real issues.
The advanced economies must urgently shift from a largely cyclical post-crisis response to more holistic structural measures. The longer this shift is delayed, the greater the pressure for ad hoc measures that generate lots of headlines but are ineffective in restoring robust medium-term growth and dynamic job creation.
This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This material was reprinted with permission of Financial Times. Date of original publication January 18, 2010.
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